How Reliable Are These Financial Rules of Thumb?
What’s a common financial rule of thumb you know? Who told you about it?
Most people find out through word-of-mouth – through a piece of advice explained by a parent or friend when approached for guidance towards buying, saving or investing. Financial rules of thumb are intended to provide guidance, and are a good starting point to begin to set your financial goals, but how reliable and effective are they?
• The 50/30/20 Rule
Perhaps the most well-known budgeting rule, it is also the most popular. It works like this: 50% of your income should go towards necessities, 20% should go towards your financial goals or debt and 30% should go towards entertainment or wants.
This rule of thumb is great when first trying to decide where to break-up and direct your money. However, this rule falls short especially when you aren’t earning enough to have the luxury of only spending half of your pay on necessities.
• The 20/4/10 Rule
This rule applies to buying a car. This rule suggests you should put down at least a 20 per cent deposit, finance the car for a maximum of 4 years only, and spend no more than 10 per cent of your yearly income on petrol, insurance and registration.
This rule works by keeping your budget in mind and directing you away from buying something that you can’t afford. However, depending on your circumstances, this rule becomes null and void. For example, you might travel far for a small income, or have the cash to pay for the car up front.
• The 20% Rule
This rule encourages you to put down a 20 per cent deposit when buying a home. This traditional piece of advice ensures that you don’t spend more than you can afford, can possibly lower your monthly repayments and means you won’t have to pay Lender’s Mortgage Insurance (LMI).
Some people consider this rule unrealistic and overwhelming, but if you are in the position to put a decent deposit down, you’ll be better off in the long run.
• 6-Month Emergency Fund Rule
This rule suggests that you should have at least six months’ worth of savings in the bank in case of an emergency.
This rule helps to prepare you for something that might go wrong in the future. In case of an emergency, like an unforeseen job loss or medical complication, a six-month savings fund could save you from making desperate decisions that might set you back.
However, due to varying arguments regarding the amount that should be saved, how long the money should last, differing personal circumstances, and whether emergency funds are needed altogether, this rule has no defined boundaries. Ultimately, it is up to you to decide what works best. Things you might take into consideration include; your income, emergencies you might be subject to, your net worth and monthly expenses.
While these rules of thumb are methods that have been shown to work in the past, they should only be used as a starting point for your own finances. When setting your own financial goals, research and planning is a necessity if you want to see effective and reliable results.
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